Do State Revenue Trends Indicate That A Recession Is Imminent?

A decline in state tax revenue has historically been a reliable leading indicator of impending recessions. As such, investors/gamblers in the current equity market bubble should probably take note of the new report just published by the National Association of State Budget Officers indicating that state revenues are just starting to decline as funding needs related to massively underfunded pensions, rising education costs, etc. continue to skyrocket.

Despite these variations, there is evidence that many states are seeing softening state tax collections. General fund revenue growth slowed considerably in fiscal 2016, after fairly robust growth in fiscal 2015. Revenues were less than budgeted in 25 states in fiscal 2016, the most since the Great Recession.

This revenue slowdown was driven by a number of factors. All three of the largest sources of general fund revenue had a lackluster performance in fiscal 2016. Personal income tax collections were negatively affected by the weak stock market gains in calendar year 2015, and corporate income tax collections outright declined. Sales tax growth was also weak, tempered by low inflation and slower growth in consumption of taxable goods and services. In addition, energy-producing states continued to grapple with the impacts of declining oil and gas prices and declining coal production on their revenue collections. Most states are seeing these weaker revenue conditions carrying into fiscal 2017. At the time of data collection, 24 states reported general fund revenues for fiscal 2017 were coming in below forecast, while 16 states were on target and four states were above forecast.

The combination of declining revenue and soaring costs forced 19 states to slash budgets in FY 2016, the highest since the "great recession". Moreover, per the chart below, an uptick in state revenue shortfalls have been a solid leading indicator of all four of the previous U.S. recessionary periods.

Per The Hill, states were forced to cut $2.8 billion out of FY 2016 budgets with energy-dependent economies being the hardest hit.

States were forced to cut a total of $2.8 billion out of their budgets in the last fiscal year, and more states are likely to face cash flow crunches in upcoming legislative sessions. Seventeen states implemented cuts to their K-12 education programs, and eleven states cut public assistance programs.

Energy-producing states like Alaska, Louisiana, New Mexico, North Dakota, Oklahoma and Wyoming were particularly hard-hit, as falling global commodity prices caused extraction tax revenues to tumble. Among the 12 states that saw revenues decline in 2016, nine are major energy producers.

Wyoming’s spending declined more than 20 percent between 2016 and 2017 as oil and coal prices fell. Spending in Alaska — which relies on taxes generated by its oil industry for a huge percentage of its overall revenue — dropped almost 10 percent, while the state hiked fees and laid off employees. Louisiana cut almost $350 million from its budget.

Meanwhile, rising budget deficits are starting to take a toll on state reserve balances used to fund budget shortfalls.

And while the aggregate data suggests the states have a cash cushion of roughly 10% of annual expenditures, a significant number of states, including the heavily pension debt burdened states of Illinois and New Jersey, are much worse off with a cushion of 5% or less.

Meanwhile, per The Hill, California's Department of Finance Director warns that a "recession is coming sometime soon" after sales tax collections have consistently missed targets in recent months on the back of lower consumption levels.

“A recession is coming sometime soon, but I think economists in all of the state offices would tell you that there’s a really hard economic forecasting angle of predicting when that’s going to happen,” said Michael Cohen, director of California’s Department of Finance.

Cohen said his state, like others, has seen sales taxes consistently miss revenue targets in recent months, spurred by lower consumption.

Lower-than-expected tax revenues are likely to force governors and state legislators of both parties to dramatically alter their plans for legislative sessions set to begin next year.

All that said, we're sure the market will find someway to spin this in a positive light so the Dow can continue its surge to 20,000.